Friday, 18 August 2017

Japan and the burden of government debt

I don’t write
enough about Japan, and now that some of my posts are very kindly
being translated into Japanese I should try to remedy that. In fact
there is currently a very good reason to write about the Japanese
economy, and that is a very strong 2017 Q2 performance. Annualised
growth was 4%, compared to 1.2% in the UK. What is particularly
heartening about recent Japanese growth is that it is led by domestic
demand rather than trade. In the past Japan seemed to have the
opposite of the UK’s problem: growth was often led by trade, while
domestic demand was weak.

This recent growth
is not just making up for poor past performance compared to other
countries. Comparisons of GDP growth are misleading for Japan because
(unlike the UK and US) it has relatively little inward migration, so
it is better to use GDP per head for such comparisons. (As Noah Smith
points
out, even this my bias comparisons against Japan because its
population is aging.) Between 2006 and 2016, Japan increased GDP per
head by a total of about 5.5%, compared to around 5% in the US and
about 3% for the UK. Good compared to other countries, but all these
countries should have had stronger recoveries from the recession.

Strong growth is
good news because inflation is so low (around 0.5%): way below the 2%
inflation target. The government is trying to stimulate growth using
a modest fiscal stimulus and large scale quantitative easing (short
and long interest rates are exactly zero) as well as
implementing various structural reforms. But the striking thing about
all this is that their net government debt to GDP ratio is
125% and rising (OECD Economic Outlook measure). This is higher than
any other OECD country except Greece and Italy.

Does the conjunction
of relatively strong growth and high government debt confound
economic theory, as Bill Mitchell suggests?
Like high powered money and inflation, any relationship between
government debt and growth just does not work when interest rates are
stuck at zero. High government debt could crowd out private
investment (although some dispute this), but not when real long term
rates are zero and inflation is near zero. Servicing high debt could
discourage labour supply, but again not when interest rates are zero.
Nor is debt a burden on future generations when the real rate of
interest is well below the growth rate.

Of course most
people think such high debt levels are a real concern because of ‘the
markets’. But the markets will only stop buying this debt if they
expect default or rampant inflation, and there is no way a government
with its own currency can be forced to default. There is also no way
it will choose to default with interest rates so low. This is the
basic truth that our leaders in the UK choose not to tell us (and
pretend otherwise).

But what happens
when growth finally raises inflation, and interest rates rise. Will
debt not be a problem then? Maybe, but only in the long term, so the
government will have plenty of time to fix that roof when the sun
shines. [1] Right now Japan does worry about its high levels of
government debt, but it rightly worries about the combination of low
growth and low inflation much more. In that sense it sets a good
example to other countries.

[1] Fixing the roof
while the sun shines is one of the Cameron/Osborne little homilies I
approve of. The problem when they used it was the UK economy was
actually in pretty poor shape, as we could tell because interest
rates were so low.

Hello. This is the link to Japanese translation of Mainly Macro http://econ101.jp/category/translation/simon-wren-lewis/ We've just started translating since this month so we haven't got many yet. Thanks! @chietherabbit

Thoughtful article as usual from SW-L. My only quibble is with this phrase: “But what happens when growth finally raises inflation, and interest rates rise. Will debt not be a problem then? Maybe, but only in the long term..”. SW-L gives no reasons why there might be a problem in the long term. Nor do I see why there should be much of a at all, short or long term. Reasons are thus.

If markets suddenly raise the interest rate demanded for holding government debt, the bill for that does not rise immediately because the rate of interest on the debt is determined when it is first issued. As to debt due for roll over, government can just print money to pay off the old debt and then stick two fingers up at potential debt holders who want more interest, and tell them to go away. That will probably raise inflation, but that can be dealt with via raised taxes.

In the case of a closed economy (to keep things simple) those taxes will not cut living standards. Reason is that those taxes simply aim to cut demand to a non-inflationary level. I.e. aggregate demand need not be affected. As to open economies, things are a little more complicated, but the end result is much the same. And in the case of Japan, that can be ignored as the vast bulk of its debt is held by Japanese natives.

One of the most interesting things about Japan is that it is in many ways a closed economy by which I mean it is able to tackle its own issues in ways it chooses, due to its relative independence.

As an illustration of this you mention investment spending and one of the reasons this is rising strongly is that there is a boom in spending on AI and robotics. Going strongly down the robotics route is one way of countering the huge demographic issues faced by Japan, made more stark by cultural exclusivity and very low immigration.

The Japanese appear to have a system of government and industry which favour a more collectivised approach to these issues and have done so for many years (the zaibatsu); in fact the moral and economic framework is quite different. In this they show an interesting counterpoint to the Western economies which are much more financialised, individual and market based and it is in these collective arrangements that they appear to be able to tackle these issues much better than we can. I would have much more faith in the ability of the Japanese government to mend the roof when the sun shines than I have in the UK government.

Perhaps Japan (and other countries too) would be best off just keeping the policy interest rate at zero indefinately and not using monetary policy to try and modulate inflation.I'm also interested in how you reconcile your very strong stance on the necessity for large scale mass net migration into the UK with your recognition of how well Japan does with so little imigration.

Seems like debt is only a problem if the % growth in revenues is less than the % interest rate on debt.

BTW, governments should be able to earn an outsized return on debt, relative to corporations, if the money gets invested in things that generate positive externalities that the government can then tax.

I used to do NPV calcs for policy decisions, is that sort of thing a big secret?

Apologies in advance for my layperson understanding, but is Japan really comparable to the UK when you consider the proportion of government debt that is held overseas (Japan very little, UK a lot)? An international investor in government debt is investing in both the bond and the currency it is denominated in. Although central banks can print money to avoid default this would devalue the currency and international bond holders would suffer losses regardless. Surely many would sell as soon as this seemed a likely course of action? This is not a problem for Japan as its debt is largely held domestically but the UK is more reliant on international creditors.

The US finances it government debt internationally. In Japan the government debt seems to be held most domestically. Should this not make a big difference? It makes Japanese government debt immune for depreciation and capital flows?

SWL's post here seems a bit of kilter to some of his earlier posts on the composition and duration of any fiscal expansion designed to contribute to escape from the UK's prolonged stagnation, e.g:

It cannot be undone by the government spending more on infrastructure: public investment is not some magic instrument that can get you any GDP you want.No economic theory that I know of suggests you can safely ignore the public finances outside of a recession. In a world where monetary policy regulates demand (absent the lower bound) then a build up in government debt risks crowding out private capital, discouraging labour supply (because higher debt has to be serviced through higher taxes) and redistributing income between generations (followed up in a response to a comments to the application of the incomprehensible 'interlapping generations model' - i'd be grateful for reference that explains it in plain english.

I am not clear whether SWL's view is that a fiscal expansion should be limited to public investment - desirable but not a panacea - as he points out; that investment-financed investment should that only be limited to a time up to when we escape the ZLB, which suggests stop-go cycle in public investment levels, which will be very difficult to time correctly, even if desirable, and, how the 'interlapping generation theory' fits the japanese situation.

I am also not clear of the precise role that carefully designed injections of 'helicopter money' might play.

Hello. This is the link to Japanese translation of Mainly Macro http://econ101.jp/category/translation/simon-wren-lewis/ We've just started translating since last month so we haven't got many yet. Thanks! @chietherabbit

You probably know both of them from the conference circuit; I haven't seen them since the East Coast Japan Economic Seminar collapsed (as has the Washington and Southeast Japan Seminar). I've switched my own research from Japan to the (global) auto industry and to China.

Since they wrote their paper, the policy of kicking the fiscal can down the road has continued. The margin of safety is very small. I didn't spot any holes in their paper, though I didn't try to put together my own spreadsheet. In particular, there's the net debt / gross debt distinction. Their argument is that doesn't really matter.

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